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The Breakfast Briefing

The rally in small-cap stocks is showing few signs of petering out in the new year.

The Russell 2000 index of small-capitalization stocks finished at another all-time high on Thursday. The record exemplifies how smaller companies that benefit from an improving U.S. economy continue to rally, and outpace their larger brethren.

The index is up 3.8% so far this year and 19.5% since the major stock indexes bottomed on June 4, outpacing both the Dow and the S&P 500 and putting it on the verge of a new bull market, considered a gain of at least 20% from a recent low.

“I would take the rally in small caps as a good sign for both the broad markets and the prospects of the U.S. economy,” Jim Dunigan, managing executive of investments at PNC Wealth Management, said in a chat with MarketBeat. “If small-cap stocks keep getting a bid, that will only bode well down the road.”

Smaller stocks are generally viewed as riskier assets than large caps. They tend to be more thinly traded, which can exacerbate their price swings in either direction. They also typically outperform during uptrends as investors become more willing to increase risk.

The Russell lagged the S&P 500 in the early part of 2012 before heading on an upswing during the second half of the year as European worries settled down and hype built that the Fed would expand its stimulus programs.

Like everything in the markets these days, the rally hinges largely on what happens next in Washington. Mr. Dunigan says one of the risk factors that could derail the small-cap rally is the continued uncertainty stemming from the nation’s capital.

Budget wrangling in Washington over spending cuts and the debt ceiling are expected to take their toll on markets in the next few months.

If that scenario plays out, small caps could be at risk for a bigger fall than their larger peers.

But for now, small stocks have been an enticing play for investors looking to take on a bit more risk. Should the housing market keep improving and overall U.S. economic keeps picking up, small caps could continue to be big beneficiaries.

Wells Fargo is forecast to reported fourth-quarter earnings of 87 cents a share, according to a consensus survey by FactSet.

“We are expecting Wells to maintain earnings in what should be a tough-margin/strong-mortgage quarter again,” analysts at Keefe, Bruyette & Woods said in a report published Wednesday.

“In the end, we would recommend investors take a more cautious position into earnings, as mortgage banking and margin could fall short of expectations,” the analysts said.

Must Reads

Ahead of the Tape: Wells Fargo Must Fight to Stay a Standout ”Make it an even dozen. That is what investors hope Wells Fargo & Co. will do when it reports fourth-quarter results Friday, kicking off big-bank earnings season. While rivals have had their ups and downs, Wells racked up 11 consecutive quarters of earnings-per-share growth through September 2012.”

AmEx to Cut 8.5% of Staff ”American Express Co. set plans to cut 5,400 jobs in its biggest retrenchment in a decade, as it pares back a travel business that has been hammered by the rise of Internet-based hotel- and airfare-reservation services.”

BATS CEO: Trade Problems ‘Part of the Business’ ”The CEO of BATS Global Markets Inc. said Thursday the exchange operator is continuing to inspect its systems for other potential problems in the wake of glitches that affected trades over more than four years.”

Herbalife Unleashes Volley at Hedge Fund ”Herbalife Ltd. trotted out slides, videos and a business-school professor Thursday as it sought to counter a hedge-fund manager’s assertion that the company is a pyramid scheme.”

Mortgage Deals Came Just in Time ”Major banks pushed to complete an $8.5 billion legal settlement with federal regulators this past weekend so they could book the deal’s costs in their fourth-quarter results and present a cleaner slate to investors in 2013, according to people familiar with the talks.”

BofA Seeks to Avoid ‘Toxic’ Countrywide Liabilities ”Bank of America Corp. has been fighting in a New York court this week to avoid as much as $3 billion in liability for defaulted Countrywide mortgage securities, but the bank’s courtroom adversary, bond insurer MBIA Inc. is wielding the bank executives’ own words in its attack.”

SAC Capital to Close Chicago Office ”SAC Capital Advisors LP said it plans to close it Chicago office. Four teams of portfolio managers and their analysts are based in the Chicago office, a satellite location of the Stamford, Conn., hedge-fund firm, according to people familiar with the company.”

Heard on the Street: Boeing Buyers Still Can’t Sleep Easy ”The latest batch of Dreamliner troubles inflicted a rough two days on Boeing’s stock this week. By Wednesday, though, at least some investors decided the panic was overdone: The shares were back into positive territory for the year so far.”

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